The newly rich: How your world changes when downsizing creates a windfall

You may never have imagined yourself sitting on a financial windfall and wondering what to do with it but many older Canadians who have lived through the housing market’s finest hours are facing just that.

If the investment in your family home has paid off handsomely over your lifetime, there might come a time to lock in those gains. You could downsize and buy a cheaper home or condo — if you knew how long you might want to live in the property and if you don’t mind all the land transfer taxes and transaction costs.

Or you could give yourself the flexibility of renting an equally nice home or condo.

The question is – what do you do with it, and what do you need to think about, when that big cheque comes from the real estate lawyer?

Here are five things to think about:

What is your new annual budget going to look like? You will have major savings on annual house upkeep and repairs and no more realty taxes. You will have major new expenses with your monthly rent. Will this end up costing you $40,000 more a year or only $10,000 more or is it closer to a break even scenario?

In order to cover off annual spending, how much, if any, do you need to draw each year from your non-registered investments? The key is not to think about how much income does this need to spin off, but rather cash flow. This income focus is a mistake that many people make, and it sometimes leads to higher risk investments and almost always in much higher taxes.

Based on your current situation, what is the chance of you outliving your money? What is your likely estate value and lifetime tax bill? These important questions may require help from a financial planner, but if you don’t already have a strong handle on this, now is the time to get it. Aside from peace of mind, having this knowledge will drive a number of decisions around your spending habits, investment strategy, gifting habits (to family or charity), tax planning and estate planning.

Your tax bill is getting very big, and you need to figure out how to make it smaller. In addition to being forced to draw 7.59% of your RRIF value (based on age 73), you are now suddenly taxed on income and realized capital gains on investments. If you earn 5% income (half Canadian dividends and half interest or U.S. dividends) on this portfolio, that works out to $35,000 of Canadian dividends and $35,000 of fully taxed interest and U.S. dividends. You could be facing over $20,000 in taxes that you weren’t facing before plus you could lose $6,700 in annual Old Age Security (OAS) payments. This is a little less painful if you are able to fully split income with your spouse, but can be very expensive if you are single.

The good news on the investment front is that you can structure the portfolio to generate much less income, cut your tax bill, and possibly even keep your full Old Age Security payment in the process. Among the tools to help accomplish this would be:

Start with an investment portfolio that has limited exposure to interest income and U.S. dividend income in the taxable investment account. This will lower the amount of income that faces the highest tax rate.

If you are paying for investment advice, try and ensure that the investment fees are tax deductible. This will lower your overall cost and also lower your taxable income and can help with OAS recovery.

Consider Corporate Class funds that have low yields and can defer capital gains – or other income limiting investments.

Look at other tax sheltering ideas such as shifting some funds to tax sheltered insurance or using flow through shares with investment certainty (a locked-in loss) that is more than offset by government tax credits.

Look at gifting strategies as part of the overall plan – both giving to family and to charity.

How do you use your wealth to make the most of your remaining years? This is touched upon above, but it is really about sitting down and saying ‘what do I want to do now? What goals do I have for myself?’ Not just the bucket list idea, but what kind of values and relationships do I want to leave with my kids and grandkids and friends? Do I want to try to make a bigger difference in other people’s lives – either financially or through other things that I can do? When you suddenly have more liquid wealth at your disposal, it is a good time to take a step back and think about what it can allow you to do?

While the selling of your family home can trigger this type of review, it can happen in other situations as well. Often it is at a time of inheritance or in some cases when a retiree chooses to take the value of their pension as a lump sum. It can even be the much rarer scenario of a lottery win.

At all of these times of positive financial change, it is important to think about how it could change your lifestyle, how your tax situation changes, what type of advice you might require, and how it might allow you to positively impact others. These situations may never come up in your life, but if it does, it is often a once in a lifetime opportunity. Plan wisely.

Ted can be reached at tedr@tridelta.ca or by phone at 416-733-3292 x221 or 1-888-816-8927 x221